CHAPTER 9

CHAPTER 9 Inventories: Additional Valuation Issues ASSIGNMENT CLASSIFICATION TABLE (BY TOPIC) Topics

Questions

Brief Exercises

Problems 1, 2, 3, 9, 10

1, 2, 3, 5

6

1. Lower-of-cost-or-market.

1, 2, 3, 4, 5, 6

1, 2, 3

1, 2, 3, 4, 5, 6

2. Inventory accounting changes; relative sales value method; net realizable value.

7, 8

4

7, 8

3. Purchase commitments.

9

5, 6

9, 10

9

4. Gross profit method.

10, 11, 12, 13

7

11, 12, 13, 14, 15, 16, 17

4, 5

5. Retail inventory method.

14, 15, 16

8

18, 19, 20, 22, 23, 26

6, 7, 8, 10, 11

6. Presentation and analysis.

17, 18

9

21

9

23

10

22, 23

12, 13, 14

11

24, 25, 26, 27

11, 13

28

13, 14

*7. LIFO retail. *8. Dollar-value LIFO retail. *9. Special LIFO problems.

Concepts for Analysis

Exercises

4, 5

7

*This material is discussed in an Appendix to the chapter.

Copyright © 2010 John Wiley & Sons, Inc.

Kieso, Intermediate Accounting, 13/e, Solutions Manual

(For Instructor Use Only)

9-1

ASSIGNMENT CLASSIFICATION TABLE (BY LEARNING OBJECTIVE) Brief Exercises

Learning Objectives

Exercises

Problems

1.

Describe and apply the lower-of-cost-or-market rule.

1, 2, 3

1, 2, 3, 4, 5, 6

1, 2, 3, 9, 10

2.

Explain when companies value inventories at net realizable value.

1, 2, 3

1, 2, 3, 4, 5, 6

1, 2, 3, 9, 10

3.

Explain when companies use the relative sales value method to value inventories.

4

7, 8

4.

Discuss accounting issues related to purchase commitments.

5, 6

9, 10

9

5.

Determine ending inventory by applying the gross profit method.

7

11, 12, 13, 14, 15, 16, 17

4, 5

6.

Determine ending inventory by applying the retail inventory method.

8

18, 19, 20

6, 7, 8

7.

Explain how to report and analyze inventory.

9

21

9

Determine ending inventory by applying the LIFO retail methods.

10, 11

22, 23, 24, 25, 26, 27, 28

11, 12, 13, 14

*8.

*This material is discussed in an Appendix to the chapter.

9-2




ASSIGNMENT CHARACTERISTICS TABLE

Item

Description

Level of Difficulty

E9-1 E9-2 E9-3 E9-4 E9-5 E9-6 E9-7 E9-8 E9-9 E9-10 E9-11 E9-12 E9-13 E9-14 E9-15 E9-16 E9-17 E9-18 E9-19 E9-20 E9-21 *E9-22 *E9-23 *E9-24 *E9-25 *E9-26 *E9-27 *E9-28

Lower-of-cost-or-market. Lower-of-cost-or-market. Lower-of-cost-or-market. Lower-of-cost-or-market—journal entries. Lower-of-cost-or-market—valuation account. Lower-of-cost-or-market—error effect. Relative sales value method. Relative sales value method. Purchase commitments. Purchase commitments. Gross profit method. Gross profit method. Gross profit method. Gross profit method. Gross profit method. Gross profit method. Gross profit method. Retail inventory method. Retail inventory method. Retail inventory method. Analysis of inventories. Retail inventory method—conventional and LIFO. Retail inventory method—conventional and LIFO. Dollar-value LIFO retail. Dollar-value LIFO retail. Conventional retail and dollar-value LIFO retail. Dollar-value LIFO retail. Change to LIFO retail.

Simple Simple Simple Simple Moderate Simple Simple Simple Simple Simple Simple Simple Simple Moderate Simple Simple Moderate Moderate Simple Simple Simple Moderate Moderate Simple Simple Moderate Moderate Simple

15–20 10–15 15–20 10–15 20–25 10–15 15–20 12–17 05–10 15–20 8–13 10–15 15–20 15–20 10–15 15–20 20–25 20–25 12–17 20–25 10–15 25–35 15–20 10–15 5–10 20–25 20–25 10–15

P9-1 P9-2 P9-3

Lower-of-cost-or-market. Lower-of-cost-or-market. Entries for lower-of-cost-or-market—direct and allowance. Gross profit method. Gross profit method. Retail inventory method. Retail inventory method.

Simple Moderate Moderate

10–15 25–30 30–35

Moderate Complex Moderate Moderate

20–30 40–45 20–30 20–30

P9-4 P9-5 P9-6 P9-7



Time (minutes)


9-3

ASSIGNMENT CHARACTERISTICS TABLE (Continued) Level of Difficulty

Time (minutes)

Moderate Moderate

20–30 30–40

P9-10 *P9-11 *P9-12 *P9-13 *P9-14

Retail inventory method. Statement and note disclosure, LCM, and purchase commitment. Lower-of-cost-or-market. Conventional and dollar-value LIFO retail. Retail, LIFO retail, and inventory shortage. Change to LIFO retail. Change to LIFO retail; dollar-value LIFO retail.

Moderate Moderate Moderate Moderate Complex

30–40 30–35 30–40 30–40 40–50

CA9-1 CA9-2 CA9-3 CA9-4 CA9-5 CA9-6 *CA9-7

Lower-of-cost-or-market. Lower-of-cost-or-market. Lower-of-cost-or-market. Retail inventory method. Cost determination, LCM, retail method. Purchase commitments. Retail inventory method and LIFO retail.

Moderate Moderate Moderate Moderate Moderate Moderate Simple

15–25 20–30 15–20 25–30 15–25 20–25 10–15

Item P9-8 P9-9

9-4

Description




SOLUTIONS TO CODIFICATION EXERCISES CE9-1 (a)

According to the Master Glossary, Inventory is defined as the aggregate of those items of tangible personal property that have any of the following characteristics: 1. Held for sale in the ordinary course of business 2. In process of production for such sale 3. To be currently consumed in the production of goods or services to be available for sale. The term inventory embraces goods awaiting sale (the merchandise of a trading concern and the finished goods of a manufacturer), goods in the course of production (work in process), and goods to be consumed directly or indirectly in production (raw materials and supplies). This definition of inventories excludes long-term assets subject to depreciation accounting, or goods which, when put into use, will be so classified. The fact that a depreciable asset is retired from regular use and held for sale does not indicate that the item should be classified as part of the inventory. Raw materials and supplies purchased for production may be used or consumed for the construction of long-term assets or other purposes not related to production, but the fact that inventory items representing a small portion of the total may not be absorbed ultimately in the production process does not require separate classification. By trade practice, operating materials and supplies of certain types of entities such as oil producers are usually treated as inventory.

(b)

According to the Master Glossary, the phrase lower-of-cost-or-market, the term market means current replacement cost (by purchase or by reproduction, as the case may be) provided that it meets both of the following conditions. 1. Market shall not exceed the net realizable value 2. Market shall not be less than net realizable value reduced by an allowance for an approximately normal profit margin.

(c)

According to the Master Glossary, two definitions are provided for the phrase Net Realizable Value 1. Estimated selling price in the ordinary course of business less reasonably predictable costs of completion and disposal. 2. Valuation of inventories at estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation.

The second definition provides a link to guidance for lower-of-cost-or-market in the agricultural industry (FASB ASC 905-330-35) Growing Crops 35-1

Costs of growing crops shall be accumulated until the time of harvest. Growing crops shall be reported at the lower-of-cost-or-market.

> Developing Animals 35-2

Developing animals to be held for sale shall be valued at the lower-of-cost-or-market.




9-5

CE9-1 (Continued) > Animals Available and Held for Sale 35-3

Animals held for sale shall be valued at either of the following: (a) The lower-of-cost-or-market (b) At sales price less estimated costs of disposal, if all the following conditions exist: 1. The product has a reliable, readily determinable, and realizable market price. 2. The product has relatively insignificant and predictable costs of disposal. 3. The product is available for immediate delivery.

Inventories of harvested crops and livestock held for sale and commonly referred to as valued at market are actually valued at net realizable value. > Harvested Crops 35-4

Inventories of harvested crops shall be valued using the same criteria as animals held for sale in the preceding paragraph.

CE9-2 According to FASB ASC 330-10-35-1 through 5: Adjustments to Lower-of-Cost-or-Market A departure from the cost basis of pricing the inventory is required when the utility of the goods is no longer as great as their cost. Where there is evidence that the utility of goods, in their disposal in the ordinary course of business, will be less than cost, whether due to physical deterioration, obsolescence, changes in price levels, or other causes, the difference shall be recognized as a loss of the current period. This is generally accomplished by stating such goods at a lower level commonly designated as market. Thus, in accounting for inventories, a loss shall be recognized whenever the utility of goods is impaired by damage, deterioration, obsolescence, changes in price levels, or other causes. The measurement of such losses shall be accomplished by applying the rule of pricing inventories at the lower-of-cost-or-market. This provides a practical means of measuring utility and thereby determining the amount of the loss to be recognized and accounted for in the current period. However, utility is indicated primarily by the current cost of replacement of the goods as they would be obtained by purchase or reproduction. In applying the rule, however, judgment must always be exercised and no loss shall be recognized unless the evidence indicates clearly that a loss has been sustained. Replacement or reproduction prices would not be appropriate as a measure of utility when the estimated sales value, reduced by the costs of completion and disposal, is lower, in which case the realizable value so determined more appropriately measures utility. In addition, when the evidence indicates that cost will be recovered with an approximately normal profit upon sale in the ordinary course of business, no loss shall be recognized even though replacement or reproduction costs are lower. This might be true, for example, in the case of production under firm sales contracts at fixed prices, or when a reasonable volume of future orders is assured at stable selling prices. In summary, the determination of the amount of the write-off should be based on factors that relate to the net realizable value of the inventory, not the amount that will maximize the loss in the current period. Note that the sale manager’s proposed accounting is an example of “cookie jar” reserves, as discussed in Chapter 4. By writing the inventory down to an unsupported low value, the company can report higher gross profit and net income in subsequent periods when the inventory is sold.

9-6




CE9-3 According to FASB ASC 330-10-35-6, if inventory has been the hedged item in a fair value hedge, the inventory’s cost basis used in the lower-of-cost-or-market accounting shall reflect the effect of the adjustments of its carrying amount made pursuant to paragraph 815-25-35-1(b). And, according to 8152-35-1(b), gains and losses on a qualifying fair value hedge shall be accounted for as follows: The gain or loss (that is, the change in fair value) on the hedged item attributable to the hedged risk shall adjust the carrying amount of the hedged item and be recognized currently in earnings.

CE9-4 See FASB ASC 210-10-S99—Regulation S-X Rule 5-02, Balance Sheets S99-1 The following is the text of Regulation S-X Rule 5-02, Balance Sheets. The purpose of this rule is to indicate the various line items and certain additional disclosures which, if applicable, and except as otherwise permitted by the Commission, should appear on the face of the balance sheets or related notes filed for the persons to whom this article pertains (see § 210.4–01(a)). • ASSETS AND OTHER DEBITS • Current Assets, when appropriate • [See § 210.4–05] • 6. Inventories. – (a) State separately in the balance sheet or in a note thereto, if practicable, the amounts of major classes of inventory such as: • 1. Finished goods; • 2. inventoried cost relating to long-term contracts or programs (see (d) below and § 210.4–05); • 3. work in process (see § 210.4–05); • 4. raw materials; and • 5. supplies. – If the method of calculating a LIFO inventory does not allow for the practical determination of amounts assigned to major classes of inventory, the amounts of those classes may be stated under cost flow assumptions other that LIFO with the excess of such total amount over the aggregate LIFO amount shown as a deduction to arrive at the amount of the LIFO inventory. – (b) The basis of determining the amounts shall be stated. If cost is used to determine any portion of the inventory amounts, the description of this method shall include the nature of the cost elements included in inventory. Elements of cost include, among other items, retained costs representing the excess of manufacturing or production costs over the amounts charged to cost of sales or delivered or in-process units, initial tooling or other deferred startup costs, or general and administrative costs. – The method by which amounts are removed from inventory (e.g., average cost, first-in, firstout, last-in, first-out, estimated average cost per unit) shall be described. If the estimated average cost per unit is used as a basis to determine amounts removed from inventory under a total program or similar basis of accounting, the principal assumptions (including, where meaningful, the aggregate number of units expected to be delivered under the program, the number of units delivered to date and the number of units on order) shall be disclosed.




9-7

CE9-4 (Continued) – If any general and administrative costs are charged to inventory, state in a note to the financial statements the aggregate amount of the general and administrative costs incurred in each period and the actual or estimated amount remaining in inventory at the date of each balance sheet. – (c)

If the LIFO inventory method is used, the excess of replacement or current cost over stated LIFO value shall, if material, be stated parenthetically or in a note to the financial statements.

– (d) For purposes of §§ 210.5–02.3 and 210.5–02.6, long-term contracts or programs include • 1. all contracts or programs for which gross profits are recognized on a percentageof-completion method of accounting or any variant thereof (e.g., delivered unit, cost to cost, physical completion), and • 2. any contracts or programs accounted for on a completed contract basis of accounting where, in either case, the contracts or programs have associated with them material amounts of inventories or unbilled receivables and where such contracts or programs have been or are expected to be performed over a period of more than twelve months. Contracts or programs of shorter duration may also be included, if deemed appropriate. – For all long-term contracts or programs, the following information, if applicable, shall be stated in a note to the financial statements: (i) The aggregate amount of manufacturing or production costs and any related deferred costs (e.g., initial tooling costs) which exceeds the aggregate estimated cost of all inprocess and delivered units on the basis of the estimated average cost of all units expected to be produced under long-term contracts and programs not yet complete, as well as that portion of such amount which would not be absorbed in cost of sales on existing firm orders at the latest balance sheet date. In addition, if practicable, disclose the amount of deferred costs by type of cost (e.g., initial tooling, deferred production, etc.) (ii) The aggregate amount representing claims or other similar items subject to uncertainty concerning their determination or ultimate realization, and include a description of the nature and status of the principal items comprising such aggregate amount. (iii) The amount of progress payments netted against inventory at the date of the balance sheet.

9-8




ANSWERS TO QUESTIONS 1.

Where there is evidence that the utility of goods to be disposed of in the ordinary course of business will be less than cost, the difference should be recognized as a loss in the current period, and the inventory should be stated at market value in the financial statements.

2.

The upper (ceiling) and lower (floor) limits for the value of the inventory are intended to prevent the inventory from being reported at an amount in excess of the net realizable value or at an amount less than the net realizable value less a normal profit margin. The maximum limitation, not to exceed the net realizable value (ceiling) covers obsolete, damaged, or shopworn material and prevents overstatement of inventories and understatement of the loss in the current period. The minimum limitation deters understatement of inventory and overstatement of the loss in the current period.

3.

The usual basis for carrying forward the inventory to the next period is cost. Departure from cost is required, however, when the utility of the goods included in the inventory is less than their cost. This loss in utility should be recognized as a loss of the current period, the period in which it occurred. Furthermore, the subsequent period should be charged for goods at an amount that measures their expected contribution to that period. In other words, the subsequent period should be charged for inventory at prices no higher than those which would have been paid if the inventory had been obtained at the beginning of that period. (Historically, the lower of cost or market rule arose from the accounting convention of providing for all losses and anticipating no profits.) In accordance with the foregoing reasoning, the rule of “cost or market, whichever is lower” may be applied to each item in the inventory, to the total of the components of each major category, or to the total of the inventory, whichever most clearly reflects operations. The rule is usually applied to each item, but if individual inventory items enter into the same category or categories of finished product, alternative procedures are suitable. The arguments against the use of the lower of cost or market method of valuing inventories include the following: (1) The method requires the reporting of estimated losses (all or a portion of the excess of actual cost over replacement cost) as definite income charges even though the losses have not been sustained to date and may never be sustained. Under a consistent criterion of realization a drop in replacement cost below original cost is no more a sustained loss than a rise above cost is a realized gain. (2) A price shrinkage is brought into the income statement before the loss has been sustained through sale. Furthermore, if the charge for the inventory write-downs is not made to a special loss account, the cost figure for goods actually sold is inflated by the amount of the estimated shrinkage in price of the unsold goods. The title “Cost of Goods Sold” therefore becomes a misnomer. (3) The method is inconsistent in application in a given year because it recognizes the propriety of implied price reductions but gives no recognition in the accounts or financial statements to the effect of the price increases. (4) The method is also inconsistent in application in one year as opposed to another because the inventory of a company may be valued at cost in one year and at market in the next year. (5) The lower of cost or market method values the inventory in the balance sheet conservatively. Its effect on the income statement, however, may be the opposite. Although the income statement for the year in which the unsustained loss is taken is stated conservatively, the net income on the income statement of the subsequent period may be distorted if the expected reductions in sales prices do not materialize.




9-9

Questions Chapter 9 (Continued) (6) In the application of the lower of cost or market rule a prospective “normal profit” is used in determining inventory values in certain cases. Since “normal profit” is an estimated figure based upon past experiences (and might not be attained in the future), it is not objective in nature and presents an opportunity for manipulation of the results of operations. 4.

The lower of cost or market rule may be applied directly to each item or to the total of the inventory (or in some cases, to the total of the components of each major category). The method should be the one that most clearly reflects income. The most common practice is to price the inventory on an item-by-item basis. Companies favor the individual item approach because tax requirements require that an individual item basis be used unless it involves practical difficulties. In addition, the individual item approach gives the most conservative valuation for balance sheet purposes.

5.

1. 2. 3. 4. 5.

6.

One approach is to record the inventory at cost and then reduce it to market, thereby reflecting a loss in the current period (often referred to as the indirect method). The loss would then be shown as a separate item in the income statement and the cost of goods sold for the year would not be distorted by its inclusion. An objection to this method of valuation is that an inconsistency is created between the income statement and balance sheet. In attempting to meet this inconsistency some have advocated the use of a special account to receive the credit for such an inventory write-down, such as Allowance to Reduce Inventory to Market which is a contra account against inventory on the balance sheet. It should be noted that the disposition of this account presents problems to accountants.

$14.30. $16.10. $13.75. $9.70. $15.90.

Another approach is merely to substitute market for cost when pricing the new inventory (often referred to as the direct method). Such a procedure increases cost of goods sold by the amount of the loss and fails to reflect this loss separately. For this reason, many theoretical objections can be raised against this procedure. 7.

An exception to the normal recognition rule occurs where (1) there is a controlled market with a quoted price applicable to specific commodities and (2) no significant costs of disposal are involved. Certain agricultural products and precious metals which are immediately marketable at quoted prices are often valued at net realizable value (market price).

8.

Relative sales value is an appropriate basis for pricing inventory when a group of varying units is purchased at a single lump sum price (basket purchase). The purchase price must be allocated in some manner or on some basis among the various units. When the units vary in size, character, and attractiveness, the basis for allocation must reflect both quantitative and qualitative aspects. A suitable basis then is the relative sales value of the units that comprise the inventory.

9.

The drop in the market price of the commitment should be charged to operations in the current year if it is material in amount. The following entry would be made [($6.40 – $5.90) X 150,000] = $75,000: Unrealized Holding Gain or Loss—Income (Purchase Commitments)........ Estimated Liability on Purchase Commitments...............................

75,000 75,000

The entry is made because a loss in utility has occurred during the period in which the market decline took place. The account credited in the above entry should be included among the current liabilities on the balance sheet with an appropriate note indicating the nature and extent of the commitment. This liability indicates the minimum obligation on the commitment contract at the present time—the amount that would have to be forfeited in case of breach of contract. 9-10




Questions Chapter 9 (Continued) 10. The major uses of the gross profit method are: (1) it provides an approximation of the ending inventory which the auditor might use for testing validity of physical inventory count; (2) it means that a physical count need not be taken every month or quarter; and (3) it helps in determining damages caused by casualty when inventory cannot be counted. 11. Gross profit as a percentage of sales indicates that the margin is based on selling price rather than cost; for this reason the gross profit as a percentage of selling price will always be lower than if based on cost. Conversions are as follows: 20% on cost = 33 1/3% on cost = 33 1/3% on selling price = 60% on selling price =

16 2/3% on selling price 25% on selling price 50% on cost 150% on cost

12. A markup of 25% on cost equals a 20% markup on selling price; therefore, gross profit equals $1,200,000 ($6 million X 20%) and net income equals $300,000 [$1,200,000 – (15% X $6 million)]. The following formula was used to compute the 20% markup on selling price: Gross profit on selling price =

Percentage markup on cost .25 = = 20% 100% + Percentage markup on cost 1 + .25

13. Inventory, January 1, 2008 Purchases to February 10, 2008 Freight-in to February 10, 2008 Merchandise available Sales to February 10, 2008 Less gross profit at 40% Sales at cost Inventory (approximately) at February 10, 2008

$ 400,000 $1,140,000 60,000

1,200,000 1,600,000

1,750,000 700,000 1,050,000 $ 550,000

14. The validity of the retail inventory method is dependent upon (1) the composition of the inventory remaining approximately the same at the end of the period as it was during the period, and (2) there being approximately the same rate of markup at the end of the year as was used throughout the period. The retail method, though ordinarily applied on a departmental basis, may be appropriate for the business as a unit if the above conditions are met. 15. The conventional retail method is a statistical procedure based on averages whereby inventory figures at retail are reduced to an inventory valuation figure by multiplying the retail figures by a percentage which is the complement of the markup percent. To determine the markup percent, original markups and additional net markups are related to the original cost. The complement of the markup percent so determined is then applied to the inventory at retail after the latter has been reduced by net markdowns, thus in effect achieving a lower of cost or market valuation. An example of reduction to market follows: Assume purchase of 100 items at $1 each, marked to sell at $1.50 each, at which price 80 were sold. The remaining 20 are marked down to $1.15 each. The inventory at $15.33 is $4.67 below original cost and is valued at an amount which will produce the “normal” 33 1/3% gross profit if sold at the present retail price of $23.00. Copyright © 2010 John Wiley & Sons, Inc.



9-11

Questions Chapter 9 (Continued) Computation of Inventory Purchases Sales Markdowns (20 X $.35) Inventory at retail Inventory at lower of cost or market $23 X 66 2/3% = $15.33

Cost

Retail

Ratio

$100

$150 (120) (7) $ 23

66 2/3%

16. (a) Ending inventory: Beginning inventory Purchases Freight-in Totals Add net markups

Cost

Retail

$ 149,000 1,400,000 70,000 1,619,000 _________ $1,619,000

$ 283,500 2,160,000 0 2,443,500 92,000 2,535,500 48,000 2,487,500 2,235,000 $ 252,500

Deduct net markdowns Deduct sales Ending inventory, at retail

Ratio of cost to selling price

$1,619,000 $2,535,500

= 64%.

Ending inventory estimated at cost = 64% X $252,500 = $161,600. (b) The retail method, above, showed an ending inventory at retail of $252,500; therefore, merchandise not accounted for amounts to $12,500 ($252,500 – $240,000) at retail and $8,000 ($12,500 X .64) at cost. 17. Information relative to the composition of the inventory (i.e., raw material, work-in-process, and finished goods); the inventory financing where significant or unusual (transactions with related parties, product financing arrangements, firm purchase commitments, involuntary liquidations of LIFO inventories, pledging inventories as collateral); and the inventory costing methods employed (lower of cost or market, FIFO, LIFO, average cost) should be disclosed. Because Deere Company uses LIFO, it should also report the LIFO RESERVE. 18. Inventory turnover measures how quickly inventory is sold. Generally, the higher the inventory turnover, the better the enterprise is performing. The more times the inventory turns over, the smaller the net margin can be to earn an appropriate total profit and return on assets. For example, a company can price its goods lower if it has a high inventory turnover. A company with a low profit margin, such as 2%, can earn as much as a company with a high net profit margin, such as 40%, if its inventory turnover is often enough. To illustrate, a grocery store with a 2% profit margin can earn as much as a jewelry store with a 40% profit margin and an inventory turnover of 1 if its turnover is more than 20 times. *19. Two major modifications are necessary. First, the beginning inventory should be excluded from the numerator and denominator of the cost to retail percentage and second, markdowns should be included in the denominator of the cost to retail percentage. 9-12




SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 9-1 (a)

Ceiling

$193.00 ($212 – $19)

Floor

$161.00 ($212 – $19 – $32)

(b)

$106.00

(c)

$51.00

BRIEF EXERCISE 9-2 Designated Item

Cost

Market

LCM

$2,000

$2,050

$2,000

Penguins

5,000

4,950

4,950

Riddlers Scarecrows

4,400 3,200

4,550 3,070

4,400 3,070

Jokers

BRIEF EXERCISE 9-3 (a)

Direct method Cost of Goods Sold....................................................

21,000

Inventory ............................................................ (b)

21,000

Indirect method Loss Due to Market Decline of Inventory ................

21,000

Allowance to Reduce Inventory to Market .....



21,000


9-13

BRIEF EXERCISE 9-4

Group

Number of CDs

Sales Price per CD

1 2 3

100 800 100

$ 5 $10 $15

Total Sales Price $

500 8,000 1,500 $10,000

*$500/$10,000 = 5/100

Relative Sales Price

Cost Allocated to CDs

Total Cost

5/100* X $8,000 = 80/100 X $8,000 = 15/100 X $8,000 =

$ 400 6,400 1,200 $8,000

Cost per CD $ 4** $ 8 $12

**$400/100 = $4

BRIEF EXERCISE 9-5 Unrealized Holding Loss—Income (Purchase Commitments) ............................................................ Estimated Liability on Purchase Commitments ....................................................

50,000 50,000

BRIEF EXERCISE 9-6 Purchases (Inventory)................................................... Estimated Liability on Purchase Commitments ........ Cash.......................................................................

950,000 50,000 1,000,000

BRIEF EXERCISE 9-7 Beginning inventory..................................................... Purchases ..................................................................... Cost of goods available ............................................... Sales .............................................................................. Less gross profit (35% X 700,000) .............................. Estimated cost of goods sold ..................................... Estimated ending inventory destroyed in fire........... 9-14


$150,000 500,000 650,000 $700,000 245,000


455,000 $195,000 (For Instructor Use Only)

BRIEF EXERCISE 9-8 Cost

Retail

Beginning inventory..............................................

$ 12,000

$ 20,000

Net purchases ........................................................ Net markups ...........................................................

120,000

170,000

Totals ......................................................................

$132,000

10,000 200,000

Deduct: Net markdowns ......................................................

7,000

Sales........................................................................

147,000

Ending inventory at retail .....................................

$ 46,000

Cost-to-retail ratio: $132,000 ÷ $200,000 = 66% Ending inventory at lower-of cost-or-market (66% X $46,000) = $30,360

BRIEF EXERCISE 9-9 Inventory turnover: $264,152 $33,685 + $31,910

= 8.05 times

2 Average days to sell inventory: 365 ÷ 8.05 = 45.3 days




9-15

*BRIEF EXERCISE 9-10

Beginning inventory............................................... Net purchases......................................................... Net markups............................................................ Net markdowns....................................................... Total (excluding beginning inventory)................. Total (including beginning inventory)..................

Cost

Retail

$ 12,000 120,000

$ 20,000 170,000 10,000 (7,000) 173,000 193,000

120,000 $132,000

Deduct: Sales......................................................... Ending inventory at retail ......................................

147,000 $ 46,000

Cost-to-retail ratio: $120,000 ÷ $173,000 = 69.4% Ending inventory at cost $20,000 X 60% ($12,000/$20,000) = $12,000 = 18,044 26,000 X 69.4% $30,044 $46,000

*BRIEF EXERCISE 9-11

Beginning inventory............................................... Net purchases......................................................... Net markups............................................................ Net markdowns....................................................... Total (excluding beginning inventory)................. Total (including beginning inventory).................. Deduct: Sales......................................................... Ending inventory at retail ......................................

9-16


Cost

Retail

$ 12,000 120,000

$ 20,000 170,000 10,000 (7,000) 173,000 193,000 147,000 $ 46,000

120,000 $132,000



*BRIEF EXERCISE 9-11 (Continued) Cost-to-retail ratio: $120,000 ÷ $173,000 = 69.4% Ending inventory at retail deflated to base year prices $46,000 ÷ 1.15 = $40,000 Ending inventory at cost $20,000 X 100% X 60% = $12,000 20,000 X 115% X 69.4% = 15,962 $27,962




9-17

SOLUTIONS TO EXERCISES EXERCISE 9-1 (15–20 minutes) Per Unit Part No. 110 111 112 113 120 121 122 Totals

Quantity 600 1,000 500 200 400 1,600 300

(a)

$334,300.

(b)

$340,500.

Cost $ 95 60 80 170 205 16 240

Market $100.00 52.00 76.00 180.00 208.00 0.50 235.00

Total Cost $ 57,000 60,000 40,000 34,000 82,000 25,600 72,000 $370,600

Total Market $ 60,000 52,000 38,000 36,000 83,200 800 70,500 $340,500

Lower-ofCost-orMarket $ 57,000 52,000 38,000 34,000 82,000 800 70,500 $334,300

EXERCISE 9-2 (10–15 minutes)

Item D E F G H I

Net Realizable Value (Ceiling) $90* 80 60 55 80 60

Net Realizable Value Less Normal Profit (Floor) $70** 60 40 35 60 40

Replacement Cost $120 72 70 30 70 30

Designated Market $90 72 60 35 70 40

Cost $75 80 80 80 50 36

LCM $75 72 60 35 50 36

*Estimated selling price – Estimated selling expense = $120 – $30 = $90. **Net realizable value – Normal profit margin = $90 – $20 = $70.

9-18




EXERCISE 9-3 (15–20 minutes) Net Real. Value Net Less Designated Replacement Realizable Normal Market

Item

Cost per

No.

Unit

Cost

Value

Profit

Value

LCM

Quantity

Value

1320 1333 1426 1437 1510 1522 1573 1626

$3.20 2.70 4.50 3.60 2.25 3.00 1.80 4.70

$3.00 2.30 3.70 3.10 2.00 2.70 1.60 5.20

$4.15* 2.90 4.60 2.75 2.45 3.50 1.75 5.50

$2.90** 2.40 3.60 1.85 1.85 3.00 1.25 4.50

$3.00 2.40 3.70 2.75 2.00 3.00 1.60 5.20

$3.00 2.40 3.70 2.75 2.00 3.00 1.60 4.70

1,200 900 800 1,000 700 500 3,000 1,000

$ 3,600 2,160 2,960 2,750 1,400 1,500 4,800 4,700***

Final Inventory

$23,870

*$4.50 – $.35 = $4.15. **$4.15 – $1.25 = $2.90. ***Cost is used because it is lower than designated market value. EXERCISE 9-4 (10–15 minutes) (a)

12/31/10

12/31/11

(b)

12/31/10

12/31/11

Cost of Goods Sold ............................... Inventory .......................................

24,000

Cost of Goods Sold ............................... Inventory .......................................

20,000

Loss Due to Market Decline of Inventory.............................................. Allowance to Reduce Inventory to Market .................................... Allowance to Reduce Inventory to Market.............................................. Recovery of Loss Due to Market Decline of Inventory .....



24,000

20,000

24,000 24,000

4,000* 4,000


9-19

EXERCISE 9-4 (Continued) *Cost of inventory at 12/31/10 ..................................... Lower-of-cost-or-market at 12/31/10......................... Allowance amount needed to reduce inventory to market (a) .............................................................

$346,000 (322,000)

Cost of inventory at 12/31/11..................................... Lower-of-cost-or-market at 12/31/11......................... Allowance amount needed to reduce inventory to market (b) .............................................................

$410,000 (390,000)

Recovery of previously recognized loss

(c)

$ 24,000

$ 20,000

= (a) – (b) = $24,000 – $20,000 = $4,000.

Both methods of recording lower-of-cost-or-market adjustments have the same effect on net income.

EXERCISE 9-5 (20–25 minutes) (a) Sales Cost of goods sold Inventory, beginning Purchases Cost of goods available Inventory, ending Cost of goods sold Gross profit Gain (loss) due to market fluctuations of inventory*

9-20


February

March

April

$29,000

$35,000

$40,000

15,000 17,000 32,000 15,100 16,900 12,100

15,100 24,000 39,100 17,000 22,100 12,900

17,000 26,500 43,500 14,000 29,500 10,500

(2,000) $10,100

1,100 $14,000

700 $11,200



EXERCISE 9-5 (Continued) *

Jan. 31

Feb. 28

Mar. 31

Apr. 30

Inventory at cost Inventory at the lower-of-costor-market Allowance amount needed to reduce inventory to market Gain (loss) due to market fluctuations of inventory**

$15,000

$15,100

$17,000

$14,000

14,500

12,600

15,600

13,300

500

$ 2,500

$ 1,400

$

700

$ (2,000)

$ 1,100

$

700

Loss Due to Market Decline of Inventory .... Allowance to Reduce Inventory to Market .............................................

500

Loss Due to Market Decline of Inventory .... Allowance to Reduce Inventory to Market .............................................

2,000

Allowance to Reduce Inventory to Market...... Recovery of Loss Due to Market Decline of Inventory...........................

1,100

Allowance to Reduce Inventory to Market...... Recovery of Loss Due to Market Decline of Inventory...........................

700

$

**$500 – $2,500 = $(2,000) $2,500 – $1,400 = $1,100 $1,400 – $700 = $700

(b)

Jan. 31

Feb. 28

Mar. 31

Apr. 30



500

2,000

1,100


700

9-21

EXERCISE 9-6 Net realizable value (ceiling) Net realizable value less normal profit (floor) Replacement cost Designated market Cost Lower-of-cost-or-market

$50 – $14 = $36 $36 – $ 9 = $27 $38 $36 Ceiling $40 $36

$38 figure used – $36 correct value per unit = $2 per unit. $2 X 1,000 units = $2,000. If ending inventory is overstated, net income will be overstated. If beginning inventory is overstated, net income will be understated. Therefore, net income for 2010 was overstated by $2,000 and net income for 2011 was understated by $2,000.

9-22




15

19

Group 2

Group 3



29

Total


19 – 2 = 17

15 – 7 = 8

* 9–5=4

17

8

Group 2

Group 3

4

Group 1

1,360 $53,040

23,120

21,760

$ 8,160

$2,040 2,720

Cost of Lots Sold

$78,000

34,000

32,000

$12,000

$24,960

10,880

10,240

$ 3,840

Gross Profit

$ 6,760

Net income

Cost Per Lot

18,200

Operating expenses

$78,000

$38,000/$125,000 X

$60,000/$125,000 X

24,960

Number of Lots Sold*

Total Cost

85,000

85,000

$27,000/$125,000 X $85,000


Gross profit

Sales

$125,000

38,000

60,000

$ 27,000

Total Sales Price

53,040

2,000

4,000

$3,000

Sales Price Per Lot

Cost of goods sold (see schedule)

Sales (see schedule)

9

Group 1

No. of Lots

$85,000

25,840

40,800

$18,360

Cost Allocated to Lots

1,360

2,720

$2,040

Cost Per Lot (Cost Allocated/ No. of Lots)


9-23

9-24

80 50

Cost per Chair $54 48 30

300 800

Number of Chairs Sold 200 100 120

Armchairs

Straight chairs

Lounge chairs

Armchairs

Straight chairs


(800 – 120) X $30 = $20,400

Inventory of straight chairs

Chairs

$90

400

No. of Chairs

Lounge chairs

Chairs

Sales Price per Chain Total Cost

6,000 $32,000

$19,200

8,000

$18,000

Sales

$40,000/$100,000 X

$24,000/$100,000 X

$12,800

2,400

3,200

$ 7,200

Gross Profit

60,000

60,000

$36,000/$100,000 X $60,000


3,600

4,800

$10,800

Cost of Chairs Sold

$100,000

40,000

24,000

$36,000

Total Sales Price

$60,000

24,000

14,400

$21,600

Cost Allocated to Chairs

30

48

$54

Cost per Chair




EXERCISE 9-9 (5–10 minutes) Unrealized Holding Gain or Loss—Income (Purchase Commitments) ................................... Estimated Liability on Purchase Commitments .............................................

25,000 25,000

EXERCISE 9-10 (15–20 minutes) (a)

If the commitment is material in amount, there should be a footnote in the balance sheet stating the nature and extent of the commitment. The footnote may also disclose the market price of the materials. The excess of market price over contracted price is a gain contingency which per FASB Statement No. 5 cannot be recognized in the accounts until it is realized.

(b)

The drop in the market price of the commitment should be charged to operations in the current year if it is material in amount. The following entry would be made: Unrealized Holding Gain or Loss—Income (Purchase Commitments) ....................................... Estimated Liability on Purchase Commitments..................................................

12,000 12,000

The entry is made because a loss in utility has occurred during the period in which the market decline took place. The account credited in the above entry should be included among the current liabilities on the balance sheet, with an appropriate footnote indicating the nature and extent of the commitment. This liability indicates the minimum obligation on the commitment contract at the present time—the amount that would have to be forfeited in case of breach of contract. (c)

Assuming the $12,000 market decline entry was made on December 31, 2011, as indicated in (b), the entry when the materials are received in January 2012 would be: Raw Materials .............................................................. 108,000 Estimated Liability on Purchase Commitments ...... 12,000 Accounts Payable..............................................



120,000


9-25

EXERCISE 9-10 (Continued) This entry debits the raw materials at the actual cost, eliminates the $12,000 liability set up at December 31, 2011, and records the contractual liability for the purchase. This permits operations to be charged this year with the $108,000, the other $12,000 of the cost having been charged to operations in 2011. EXERCISE 9-11 (8–13 minutes) (1)

20% 100% + 20%

= 16.67% OR 16 2/3%.

(2)

25% 100% + 25%

= 20%.

(3)

33 1/3% = 25%. 100% + 33 1/3%

(4)

50% 100% + 50%

= 33.33% OR 33 1/3%.


9-26

Inventory, May 1 (at cost) .................................... Purchases (at cost)............................................... Purchase discounts.............................................. Freight-in ............................................................... Goods available (at cost)............................ Sales (at selling price).......................................... Sales returns (at selling price) ............................ Net sales (at selling price) ................................... Less: Gross profit (25% of $930,000) ................ Sales (at cost) .............................................. Approximate inventory, May 31 (at cost) ...................................... Copyright © 2010 John Wiley & Sons, Inc.

$160,000 640,000 (12,000) 30,000 818,000 $1,000,000 (70,000) 930,000 232,500


697,500 $120,500 (For Instructor Use Only)

EXERCISE 9-12 (Continued) (b) Gross profit as a percent of sales must be computed: 25% = 20% of sales. 100% + 25% Inventory, May 1 (at cost).................................. Purchases (at cost)............................................ Purchase discounts........................................... Freight-in............................................................. Goods available (at cost) ......................... Sales (at selling price) ....................................... Sales returns (at selling price) ......................... Net sales (at selling price) ................................ Less: Gross profit (20% of $930,000).............. Sales (at cost) ........................................... Approximate inventory, May 31 (at cost)....................................

$160,000 640,000 (12,000) 30,000 818,000 $1,000,000 (70,000) 930,000 186,000 744,000 $ 74,000


Merchandise on hand, January 1 ..................... Purchases ........................................................... Less: Purchase returns and allowances ........ Freight-in............................................................. Total merchandise available (at cost) .... Cost of goods sold* ........................................... Ending inventory................................................ Less: Undamaged goods ................................. Estimated fire loss ............................................. *Gross profit =

$ 38,000 92,000 (2,400) 3,400 131,000 90,000 41,000 10,900 $ 30,100

33 1/3% = 25% of sales. 100% + 33 1/3%

Cost of goods sold = 75% of sales of $120,000 = $90,000.




9-27

EXERCISE 9-13 (Continued) (b)

Cost of goods sold = 66 2/3% of sales of $120,000 = $80,000 Total merchandise available (at cost) .............................. [$131,000 [as computed in (a)] – $80,000]

$51,000

Less: Undamaged goods..................................................

10,900

Estimated fire loss..............................................................

$40,100

EXERCISE 9-14 Beginning inventory....................................................

$170,000

Purchases ....................................................................

450,000 620,000

Purchase returns.........................................................

(30,000)

Goods available (at cost)............................................

590,000

Sales ............................................................................. Sales returns................................................................

$650,000 (24,000)

Net sales....................................................................... Less: Gross profit (30% X $626,000) ........................

626,000 (187,800)

438,200

Estimated ending inventory (unadjusted for damage).....................................................................

151,800

Less: Goods on hand—undamaged (at cost) $21,000 X (1 – 30%)..........................................

(14,700)

Less: Goods on hand—damaged (at net realizable value) ............................................... Fire loss on inventory .................................................

9-28



(5,300) $131,800


EXERCISE 9-15 (10–15 minutes) Beginning inventory (at cost)..................................... Purchases (at cost) ..................................................... Goods available (at cost)................................... Sales (at selling price)................................................. Less sales returns ....................................................... Net sales ....................................................................... Less: Gross profit* (20% of $112,000)...................... Net sales (at cost)............................................... Estimated inventory (at cost) ..................................... Less: Goods on hand ($30,500 – $6,000) ..................

$ 38,000 90,000 128,000 $116,000 4,000 112,000 22,400 89,600 38,400 24,500

Claim against insurance company ............................

$ 13,900

25% = 20% of selling price 100% + 25%

*Computation of gross profit:

Note: Depending on details of the consignment agreement and Garnett’s insurance policy, the consigned goods might be covered by Garnett’s insurance policy.


Inventory 1/1/11 (cost) Purchases to 8/18/11 (cost) Cost of goods available Deduct cost of goods sold* Inventory 8/18/11

Lumber

Millwork

Hardware

$ 250,000 1,500,000 1,750,000 1,640,000 $ 110,000

$ 90,000 375,000 465,000 410,000 $ 55,000

$ 45,000 160,000 205,000 175,000 $ 30,000

*(See computations on next page)




9-29

EXERCISE 9-16 (Continued) Computation for cost of goods sold:* Lumber:

$2,050,000 = $1,640,000 1.25

Millwork:

$533,000 1.30

= $410,000

Hardware:

$245,000 1.40

= $175,000

*Alternative computation for cost of goods sold: Markup on selling price:

Cost of goods sold:

Lumber:

25% = 20% or 1/5 100% + 25%

$2,050,000 X 80% = $1,640,000

Millwork:

30% = 3/13 100% + 30%

$533,000 X 10/13 = $410,000

Hardware:

40% = 2/7 100% + 40%

$245,000 X 5/7 = $175,000

9-30




EXERCISE 9-17 (20–25 minutes) Ending inventory: (a)

(b)

Gross profit is 40% of sales Total goods available for sale (at cost) ......... Sales (at selling price) .....................................

$2,100,000 $2,300,000

Less: Gross profit (40% of sales)..................

920,000

Sales (at cost) .......................................

1,380,000

Ending inventory (at cost) ...................

$ 720,000

Gross profit is 60% of cost 60% 100% + 60%

= 37.5% markup on selling price

Total goods available for sale (at cost) ......... Sales (at selling price) ..................................... Less: Gross profit (37.5% of sales)...............

$2,100,000 $2,300,000 862,500

Sales (at cost) ....................................... Ending inventory (at cost) ...................

(c)

1,437,500 $ 662,500

Gross profit is 35% of sales Total goods available for sale (at cost) ......... Sales (at selling price) .....................................

$2,100,000 $2,300,000

Less: Gross profit (35% of sales)..................

805,000

Sales (at cost) .......................................

1,495,000

Ending inventory (at cost) ...................

$ 605,000




9-31

EXERCISE 9-17 (Continued) (d)

Gross profit is 25% of cost 25% 100% + 25%

= 20% markup on selling price

Total goods available for sale (at cost) ......... Sales (at selling price)..................................... Less: Gross profit (20% of sales) .................. Sales (at cost)................................................... Ending inventory (at cost) ..............................

$2,100,000 $2,300,000 460,000 1,840,000 $ 260,000

EXERCISE 9-18 (20–25 minutes) (a) Beginning inventory ........................................ Purchases ......................................................... Net markups ..................................................... Totals .......................................................

Cost

Retail

$ 58,000 122,000

$100,000 200,000 20,000 320,000

$180,000

Net markdowns ................................................ Sales price of goods available ....................... Deduct: Sales .................................................. Ending inventory at retail................................

(b)

9-32

1.

$180,000 ÷ $300,000 = 60%

2.

$180,000 ÷ $270,000 = 66.67%

3.

$180,000 ÷ $320,000 = 56.25%

4.

$180,000 ÷ $290,000 = 62.07%



(30,000) 290,000 186,000 $104,000


EXERCISE 9-18 (Continued) (c)

1. 2. 3.

Method 3. Method 3. Method 3.

(d)

56.25% X $104,000 = $58,500

(e)

$180,000 – $58,500 = $121,500

(f)

$186,000 – $121,500 = $64,500


Beginning inventory.......................... Purchases........................................... Totals ......................................... Add: Net markups Markups.................................... Markup cancellations.............. Totals ..................................................

Cost $ 200,000 1,425,000 1,625,000

_________ $1,625,000

Deduct: Net markdowns Markdowns................................ Markdown cancellations.......... Sales price of goods available ......... Deduct: Sales .................................... Ending inventory at retail ................. Cost-to-retail ratio =

$1,625,000 $2,500,000

Retail $ 280,000 2,140,000 2,420,000 $95,000 (15,000)

35,000 (5,000)

80,000 2,500,000

30,000 2,470,000 2,250,000 $ 220,000

= 65%

Ending inventory at cost = 65% X $220,000 = $143,000




9-33


Beginning inventory............................... Purchases ............................................... Purchase returns.................................... Freight on purchases............................. Totals.............................................. Add: Net markups Markups ........................................ Markup cancellations .................. Net markups............................................ Totals..............................................

Cost $30,000 55,000 (2,000) 2,400 85,400 $10,000 (1,500) _______ $85,400

Deduct: Net markdowns Markdowns .................................... Markdown cancellations .............. Net markdowns....................................... Sales price of goods available.............. Deduct: Net sales ($95,000 – $2,000) ... Ending inventory, at retail ..................... Cost-to-retail ratio =

$85,400 $140,000

Retail $ 46,500 88,000 (3,000) _______ 131,500

8,500 140,000

9,300 (2,800) 6,500 133,500 93,000 $ 40,500

= 61%

Ending inventory at cost = 61% X $40,500 = $24,705


Inventory turnover: 2007

2006

$7,955 = 7.14 times $1,174 + $1,055 2 (b)

9-34

Average days to sell inventory: 2007 365 ÷ 7.14 = 51.1 days Copyright © 2010 John Wiley & Sons, Inc.

$7,545 $1,055 + $1,037 2

= 7.21 times

2006 365 ÷ 7.21 = 50.6 days



*EXERCISE 9-22 (25–35 minutes) (a)

Conventional Retail Method Inventory, January 1, 2011 .................... Purchases (net) ...................................... Add: Net markups ................................. Totals............................................. Deduct: Net markdowns ....................... Sales price of goods available.............. Deduct: Sales (net)................................ Ending inventory at retail ......................

Cost-to-retail ratio =

$191,100 $273,000

Cost

Retail

$ 41,100 150,000 191,100

$ 60,000 191,000 251,000 22,000 273,000 13,000 260,000 167,000 $ 93,000

$191,100

= 70%

Ending inventory at cost = 70% X $93,000 = $65,100 (b)

LIFO Retail Method Inventory, January 1, 2011 ........................ Net purchases............................................. Net markups................................................ Net markdowns........................................... Total (excluding beginning inventory)..... Total (including beginning inventory) ..... Deduct sales (net) ...................................... Ending inventory at retail ..........................



$150,000 $200,000

Cost

Retail

$ 41,100 150,000

$ 60,000 191,000 22,000 (13,000) 200,000 260,000 167,000 $ 93,000

150,000 $191,100

= 75%



9-35

*EXERCISE 9-22 (Continued) Computation of ending inventory at LIFO cost, 2011: Ending Inventory at Retail Prices

Layers at Retail Prices

$93,000

2010 $60,000 2011 33,000

*$41,100 $60,000

Cost-to-Retail Percentage

Ending Inventory at LIFO Cost

68.5%* 75.0%

$41,100 24,750 $65,850

X X

(prior years cost to retail)

*EXERCISE 9-23 (15–20 minutes) (a) Inventory, January 1, 2011.................... Net Purchases ........................................ Freight-in................................................. Net markups ........................................... Totals .............................................

Cost

Retail

$14,000 55,500 7,500

$ 20,000 81,000 9,000 110,000

$77,000

Sales ........................................................ Net markdowns ......................................

(75,000) (2,500)

Estimated theft .......................................

(2,000)

Ending inventory at retail......................

Cost-to-retail ratio:

$77,000 $110,000

$ 30,500

= 70%

Ending inventory at lower-of-average-cost-or-market = $30,500 X 70% = $21,350

9-36




*EXERCISE 9-23 (Continued) (b) Purchases ............................................... Freight-in................................................. Net markups............................................ Net markdowns....................................... Totals..............................................

Cost-to-retail ratio:

$63,000 $87,500

Cost

Retail

$55,500 7,500

$81,000 9,000 (2,500) $87,500

______ $63,000

= 72%

The increment at retail is $30,500 – $20,000 = $10,500. The increment is costed at 72% X $10,500 = $7,560. Ending inventory at LIFO retail: Beginning inventory, 2011 .................... Increment ................................................ Ending inventory, 2011..........................

Cost

Retail

$14,000 7,560 $21,560

$20,000 10,500 $30,500


Cost-to-retail ratio—beginning inventory:

$222,000 = 74% $300,000

*($294,300 ÷ 1.09) X 74% = $199,800 *Since the above computation reveals that the inventory quantity has declined below the beginning level, it is necessary to convert the ending inventory to beginning-of-the-year prices (by dividing by 1.09) and then multiply it by the beginning cost-to-retail ratio (74%).




9-37

*EXERCISE 9-24 (Continued) (b)

Ending inventory at retail prices deflated $359,700 ÷ 1.09 ....................................................... Beginning inventory at beginning-of-year prices ................ Inventory increase in terms of beginning-of-year dollars..................................................... Beginning inventory (at cost) ................................................. Additional layer, $30,000 X 1.09 X 76%* ................................

$330,000 (300,000) $ 30,000 $222,000 24,852 $246,852

*($364,800 ÷ $480,000)

*EXERCISE 9-25 (5–10 minutes) Ending inventory at retail (deflated) $95,150 ÷ 1.10 ..................... Beginning inventory at retail........................................................... Increment at retail ............................................................................ Ending inventory on LIFO basis First layer ................................................................................. Second layer ($12,000 X 1.10 X 55%)....................................

9-38



$86,500 (74,500) $12,000 Cost $36,000 7,260 $43,260



(b)

Cost Beginning inventory .......................................... $ 34,300 Net purchases..................................................... 108,500 Net markups........................................................ Totals.......................................................... $142,800 Net markdowns................................................... Sales .................................................................... Ending inventory at retail ..................................

Retail $ 50,000 150,000 10,000 210,000 (5,000) (128,000) $ 77,000

Cost-retail ratio = 68% ($142,800/$210,000) Ending inventory at cost ($77,000 X 68%).......

$ 52,360

Cost Beginning inventory ........................................... $ 34,300 Net purchases...................................................... 108,500 Net markups......................................................... Net markdowns.................................................... Total (excluding beginning inventory).............. 108,500 Total (including beginning inventory) .............. $142,800 Sales ..................................................................... Ending inventory at retail (current) ................... Ending inventory at retail (base year) ($77,000 ÷ 1.10)................................................. Cost-retail ratio for new layer: $108,500/$155,000 = 70% Layers: Base layer $50,000 X 1.00 X 68.6%* = ...................... New layer ($70,000 – $50,000) X 1.10 X 70% = ......

Retail $ 50,000 150,000 10,000 (5,000) 155,000 205,000 (128,000) 77,000 $ 70,000

$ 34,300 15,400 $ 49,700

*($34,300/$50,000) (c)

Cost of goods available for sale........................ Ending inventory at cost, from (b) .................... Cost of goods sold..............................................



$142,800 (49,700) $ 93,100


9-39

*EXERCISE 9-27 (20–25 minutes) 2009

Restate to base-year retail ($121,900 ÷ 1.06)

$115,000

Layers: 1. $100,000 X 1.00 X 54%* = 2. $ 15,000 X 1.06 X 57% = Ending inventory

$ 54,000 9,063 $ 63,063

*$54,000 ÷ $100,000 2010

2011

2012


$125,000

Layers: 1. $100,000 X 1.00 X 54% = 2. $ 15,000 X 1.06 X 57% = 3. $ 10,000 X 1.11 X 60% = Ending inventory

$ 54,000 9,063 6,660 $ 69,723


$110,000

Layers: 1. $100,000 X 1.00 X 54% = 2. $ 10,000 X 1.06 X 57% = Ending inventory

$ 54,000 6,042 $ 60,042


$130,000

Layers: 1. $100,000 X 1.00 X 54% = 2. $ 10,000 X 1.06 X 57% = 3. $ 20,000 X 1.25 X 58% = Ending inventory

$ 54,000 6,042 14,500 $ 74,542

*EXERCISE 9-28 (5–10 minutes) Inventory (beginning).................................................. Adjustment to Record Inventory at Cost* ($210,600 – $205,000)......................................

5,600 5,600

*Note: This account is an income statement account showing the effect of changing from a lower-of-cost-or-market approach to a straight cost basis. 9-40




TIME AND PURPOSE OF PROBLEMS Problem 9-1 (Time 10–15 minutes) Purpose—to provide the student with an understanding of the lower-of-cost-or-market approach to inventory valuation, similar to Problem 9-2. The major difference between these problems is that Problem 9-1 provides some ambiguity to the situation by changing the catalog prices near the end of the year. Problem 9-2 (Time 25–30 minutes) Purpose—to provide the student with an understanding of the lower-of-cost-or-market approach to inventory valuation. The student is required to examine a number of individual items and apply the lower-of-cost-or-market rule and to also explain the use and value of the lower-of-cost-or-market rule. Problem 9-3 (Time 30–35 minutes) Purpose—to provide a problem that requires entries for reducing inventory to lower-of-cost-or-market under the perpetual inventory system using both the direct and the indirect method. Problem 9-4 (Time 20–30 minutes) Purpose—to provide another problem where a fire loss must be computed using the gross profit method. Certain goods remained undamaged and therefore an adjustment is necessary. In addition, the inventory was subject to an obsolescence factor which must be considered. Problem 9-5 (Time 40–45 minutes) Purpose—to provide the student with a complex problem involving a fire loss where the gross profit method must be employed. The problem is complicated because a number of adjustments must be made to the purchases account related to merchandise returned, unrecorded purchases, and shipments in transit. In addition, some cash to accrual computations are necessary. Problem 9-6 (Time 20–30 minutes) Purpose—to provide the student with a problem on the retail inventory method. The problem is relatively straightforward although transfers-in from other departments as well as the proper treatment for normal spoilage complicate the problem. A good problem that summarizes the essentials of the retail inventory method. Problem 9-7 (Time 20–30 minutes) Purpose—to provide the student with a problem on the retail inventory method. This problem is similar to Problem 9-6, except that a few different items must be evaluated in finding ending inventory at retail and cost. Unusual items in this problem are employee discounts granted and loss from breakage. A good problem that summarizes the essentials of the retail inventory method. Problem 9-8 (Time 20–30 minutes) Purpose—to provide the student with a problem on the retail inventory method. This problem is similar to Problems 9-6 and 9-7, except that the student is asked to list the factors that may have caused the difference between the computed inventory and the physical count. Problem 9-9 (Time 30–40 minutes) Purpose—to provide the student with a problem requiring financial statement and note disclosure of inventories, the income statement disclosure of an inventory market decline, and the treatment of purchase commitments. Problem 9-10 (Time 30–40 minutes) Purpose—to provide the student with an opportunity to write a memo explaining what is designated market value and how it is computed. As part of this memo, the student is required to compute inventory on the lower-of-cost-or-market basis using the individual item approach.




9-41

Time and Purpose of Problems (Continued) *Problem 9-11 (Time 30–35 minutes) Purpose—to provide the student with a retail inventory problem where both the conventional retail and dollar-value LIFO method must be computed. An excellent problem for highlighting the difference between these two approaches to inventory valuation. It should be noted that the cost-to-retail percentage is given for LIFO so less computation is necessary. *Problem 9-12 (Time 30–40 minutes) Purpose—to provide the student with a comprehensive problem covering the retail and LIFO retail inventory methods, the computation of an inventory shortage, and the treatment of four special items relative to the retail inventory method. *Problem 9-13 (Time 30–40 minutes) Purpose—to provide the student with a basic problem illustrating the change from conventional retail to LIFO retail. This problem emphasizes many of the same issues as Problem 9-11, except that a dollarvalue LIFO computation is not needed. A good problem for providing the essential issues related to a change to LIFO retail. *Problem 9-14 (Time 40–50 minutes) Purpose—to provide the student with a retail inventory problem where both the conventional retail and dollar-value LIFO method must be computed. The problem is similar to Problem 9-10, except that the problem involves a three-year period which adds complexity to the problem. This problem provides an excellent summary of the essential elements related to the change of the retail inventory method from conventional retail to LIFO retail and dollar-value LIFO retail.

9-42




SOLUTIONS TO PROBLEMS PROBLEM 9-1

Item

Cost

Replacement Cost

A

$470

$ 460

$ 450

$350

B C D

450 830 960

430 610 1,000

480 820 1,070

372 640 830

Ceiling*

Floor**

Designated Market $

Lower-ofCost-orMarket

450

$450

430 640 1,000

430 640 960

*Ceiling = 2011 catalog selling price less sales commissions and estimated other costs of disposal. (2011 catalogue prices are in effect as of 12/01/10.) **Floor = Ceiling less (20% X 2011 catalog selling price).




9-43

PROBLEM 9-2

(a)

1.

The balance in the Allowance to Reduce Inventory to Market at May 31, 2010, should be $34,600, as calculated in Exhibit 1 below. Exhibit 1 CALCULATIONS OF PROPER BALANCE in the Allowance to Reduce Inventory to Market At May 31, 2010

NRV (Ceiling)

NRV less normal profit (Floor)

LCM

$ 62,500

$ 56,000

$ 50,900

$ 56,000

86,000

79,400

84,800

77,400

79,400

Louvered glass doors

112,000

124,000

168,300

149,800

112,000

Thermal windows

140,000

126,000

140,000

124,600

126,000

$408,000

$391,900

$449,100

$402,700

$373,400

Aluminum siding

Cost

Replacement Cost

$ 70,000

Cedar shake siding

Totals

Inventory cost

$408,000

LCM valuation

373,400

Allowance at May 31, 2010

2.

$ 34,600

For the fiscal year ended May 31, 2010, the loss that would be recorded due to the change in the Allowance to Reduce Inventory to Market would be $7,100, as calculated below. Balance prior to adjustment................................. Required balance .................................................. Loss to be recorded ..............................................

9-44



$27,500 (34,600) $( 7,100)


PROBLEM 9-2 (Continued) (b)

The use of the lower-of-cost-or-market (LCM) rule is based on both the expense recognition principle and the concept of conservatism. The expense recognition principle applies because the application of the LCM rule allows for the recognition of a decline in the utility (value) of inventory as a loss in the period in which the decline takes place. The departure from the cost principle for inventory valuation is permitted on the basis of conservatism. The general rule is that the historical cost principle is abandoned when the future utility of an asset is no longer as great as its original cost.




9-45

PROBLEM 9-3

(a)

(b)

12/31/10 (Direct Method) Cost of Goods Sold ................................................... Inventory............................................................

68,000

12/31/11 Cost of Goods Sold ................................................... Inventory............................................................

75,000

12/31/10 (Allowance Method) To write down inventory to market: Loss Due to Market Decline of Inventory ................ Allowance to Reduce Inventory to Market..... 12/31/11 To write down inventory to market: Loss Due to Market Decline of Inventory ................ Allowance to Reduce Inventory to Market [($905,000 – $830,000) – $68,000].................

9-46


68,000

75,000

68,000 68,000

7,000


7,000


PROBLEM 9-4

Beginning inventory......................................................

$ 80,000

Purchases.......................................................................

290,000

Purchase returns ...........................................................

370,000 (28,000)

Total goods available .................................................... Sales................................................................................ Sales returns ..................................................................

342,000 $415,000 (21,000) 394,000

Less: Gross profit (35% of $394,000) .........................

137,900

Ending inventory (unadjusted for damage)................

(256,100) 85,900

Less: Goods on hand—undamaged ($30,000 X [1 – 35%])..........................................

19,500

Inventory damaged........................................................ Less: Salvage value of damaged inventory...............

66,400 8,150

Fire loss on inventory ...................................................

$ 58,250




9-47

PROBLEM 9-5

STANISLAW CORPORATION Computation of Inventory Fire Loss April 15, 2011 Inventory, 1/1/11 ............................................. Purchases, 1/1/ – 3/31/11 ............................... April merchandise shipments paid .............. Unrecorded purchases on account.............. Total ...................................................... Less: Shipments in transit ........................... Merchandise returned........................ Merchandise available for sale ..................... Less estimated cost of sales: Sales, 1/1/ – 3/31/11 ............................. Sales, 4/1/ – 4/15/11 Receivables acknowledged at 4/15/11 ..................................... Estimated receivables not acknowledged............................. Total ................................................ Add collections, 4/1/ – 4/15/11 ($12,950 – $950) ................................ Total ................................................ Less receivables, 3/31/11.................... Total sales 1/1/ – 4/15/11............... Less gross profit (45%* X $161,000) ............ Estimated merchandise inventory ............... Less: Sale of salvaged inventory ................ Inventory fire loss ..........................................

9-48


$ 75,000 52,000 3,400 15,600 146,000 $

2,300 950

3,250 142,750

135,000

$46,000 8,000 54,000 12,000 66,000 40,000

26,000 161,000 72,450


88,550 54,200 3,500 $ 50,700


PROBLEM 9-5 (Continued) *Computation of Gross Profit Ratio Net sales, 2009 ..................................................

$390,000

Net sales, 2010 .................................................. Total net sales ........................................

530,000 920,000

Beginning inventory......................................... Net purchases, 2009.........................................

$ 66,000 235,000

Net purchases, 2010.........................................

280,000

Total.........................................................

581,000

Less: Ending inventory...................................

75,000

Gross profit ...........................................

506,000 $414,000

Gross profit ratio ($414,000 ÷ $920,000) ........

45%




9-49

PROBLEM 9-6

(a)

Cost

Retail

Beginning Inventory ............................. $ 17,000 Purchases .............................................. Freight-in................................................

82,500 7,000

Purchase returns .................................. Transfers in from suburban branch....

(2,300) 9,200

$ 25,000 137,000 (3,000) 13,000

Totals ............................................ $113,400

172,000

Net markups ..........................................

8,000 180,000 (4,000)

Net markdowns ..................................... Sales ....................................................... Sales returns .........................................

$(95,000) 2,400

Inventory losses due to breakage....... Ending inventory at retail.....................


(b)

9-50

$113,400 $180,000

(400) $ 83,000

= 63%

Ending inventory at lower-of-average-cost-or-market (63% of $83,000) ..................................


(92,600)


$ 52,290


PROBLEM 9-7

Beginning Inventory............................

Cost

Retail

$ 250,000

$ 390,000

Purchases............................................. Purchase returns .................................

914,500 (60,000)

Purchase discounts ............................ Freight-in ..............................................

(18,000) 42,000

Markups ................................................ Markup cancellations .......................... Totals ...........................................

1,460,000 (80,000)

$

120,000 (40,000)

$1,128,500

1,850,000

Markdowns ...........................................

(45,000)

Markdown cancellations .....................

20,000

Sales......................................................

80,000

(25,000)

(1,410,000)

Sales returns ........................................

97,500

Inventory losses due to breakage .....

(1,312,500) (4,500)

Employee discounts............................

(8,000)

Ending inventory at retail ...................


$1,128,500 $1,850,000

= 61%

Ending inventory at cost (61% of $500,000)..............................


$ 500,000


$ 305,000


9-51

PROBLEM 9-8

(a)

Cost Inventory (beginning) ........................ Purchases ........................................... Purchase returns ............................... Freight-in............................................. Totals ......................................... Markups .............................................. Markup cancellations ........................

Retail

$ 52,000 272,000 (5,600) 16,600 $335,000

$ 78,000 423,000 (8,000) 493,000 9,000 (2,000)

Net markdowns .................................. Normal spoilage and breakage......... Sales .................................................... Ending inventory at retail.................. Cost-to-retail ratio =

$335,000 $500,000

= 67%

Ending inventory at lower-of-cost-or-market (67% of $96,400) .............................. (b)

9-52

7,000 500,000 (3,600) (10,000) (390,000) $ 96,400

$ 64,588

The difference between the inventory estimate per retail method and the amount per physical count may be due to: 1. Theft losses (shoplifting or pilferage). 2. Spoilage or breakage above normal. 3. Differences in cost/retail ratio for purchases during the month, beginning inventory, and ending inventory. 4. Markups on goods available for sale inconsistent between cost of goods sold and ending inventory. 5. A wide variety of merchandise with varying cost/retail ratios. 6. Incorrect reporting of markdowns, additional markups, or cancellations.




PROBLEM 9-9

(a)

The inventory section of Maddox’s balance sheet as of November 30, 2010, including required footnotes, is presented below. Also presented below are the inventory section supporting calculations. Current assets Inventory Section (Note 1.) Finished goods (Note 2.)........................... Work-in-process......................................... Raw materials............................................. Factory supplies ........................................ Total inventories ........................................

$643,000 108,700 237,400 64,800 $1,053,900

Note 1.

Lower-of-cost (first-in, first-out) or-market is applied on a major category basis for finished goods, and on a total inventory basis for work-in-process, raw materials, and factory supplies.

Note 2.

Seventy-five percent of bar end shifters finished goods inventory in the amount of $136,500 ($182,000 X .75) is pledged as collateral for a bank loan, and one-half of the head tube shifters finished goods is held by catalog outlets on consignment.




9-53

PROBLEM 9-9 (Continued) Supporting Calculations

Down tube shifters at market........ Bar end shifters at cost ................. Head tube shifters at cost ............. Work-in-process at market............ Derailleurs at market ..................... Remaining items at market ........... Supplies at cost ............................. Totals....................................

Finished Goods $266,000 182,000 195,000

Work-inProcess

Raw Materials

Factory Supplies

$108,700 $110,0001 127,400 $643,000

$108,700

$237,400

$64,8002 $64,800

1

$264,000 X 1/2 = $132,000; $132,000 ÷ 1.2 = $110,000. $69,000 – $4,200 = $64,800.

2

(b)

The decline in the market value of inventory below cost may be reported using one or two alternate methods, the direct write-down of inventory or the establishment of an allowance account. The decline in the market value of inventory may be reflected in Maddox’s income statement as a separate loss item for the fiscal year ended November 30, 2010. The loss amount may also be written off directly, increasing the cost of goods sold on Maddox’s income statement. The loss must be reported in continuing operations rather than in extraordinary items. The loss must be included in the income statement since it is material to Maddox’s financial statements.

(c)

Purchase contracts for which a firm price has been established should be disclosed on the financial statements of the buyer. If the contract price is greater than the current market price and a loss is expected when the purchase takes place, an unrealized holding loss amounting to the difference between the contracted price and the current market price should be recognized on the income statement in the period during which the price decline takes place. Also, an estimated liability on purchase commitments should be recognized on the balance sheet. The recognition of the loss is unnecessary if a firm sales commitment exists which precludes the loss.

9-54




PROBLEM 9-10

(a)

Schedule A

Item

On Hand Quantity

Replacement Cost/Unit

NRV (Ceiling)

NRV— Normal Profit (Floor)

A B C D E

1,100 800 1,000 1,000 1,400

$8.40 7.90 5.40 4.20 6.30

$9.00 8.50 6.05 5.50 6.00

$7.20 7.30 5.45 4.00 5.00

Designated Market

Cost


$8.40 7.90 5.45 4.20 6.00

$7.50 8.20 5.60 3.80 6.40

$7.50 7.90 5.45 3.80 6.00

Schedule B Item A B C D E

(b)

Cost 1,100 X $7.50 = $8,250 800 X $8.20 = $6,560 1,000 X $5.60 = $5,600 1,000 X $3.80 = $3,800 1,400 X $6.40 = $8,960

Lower-of-Cost-or-Market 1,100 X $7.50 = $8,250 800 X $7.90 = $6,320 1,000 X $5.45 = $5,450 1,000 X $3.80 = $3,800 1,400 X $6.00 = $8,400

Cost of Goods Sold..................................................... Inventory ..............................................................

Difference None $240 $150 None $560 $950 950 950

or Loss Due to Market Decline of Inventory ................ Allowance to Reduce Inventory to Market .....



950


950

9-55

PROBLEM 9-10 (Continued) (c) To:

Greg Forda, Clerk

From:

Accounting Manager

Date:

January 14, 2011

Subject:

Instructions on determining lower-of-cost-or-market for inventory valuation

This memo responds to your questions regarding our use of lower-of-costor-market for inventory valuation. Simply put, value inventory at whichever is the lower: the actual cost or the market value of the inventory at the time of valuation. The term cost is relatively simple. It refers to the amount our company paid for our inventory including costs associated with preparing the inventory for sale. The term market, on the other hand, is more complicated. As you have already noticed, this value could be the inventory’s replacement cost, its net realizable value (selling price minus any estimated costs to complete and sell), or its net realizable value less a normal profit margin. The profession requires that the middle value of the three above costs be chosen as the “designated market value.” This designated market value is then compared to the actual cost in determining the lower-of-cost-or-market. Refer to Item A on the attached schedule. The values for the replacement cost, net realizable value, and net realizable value less a normal profit margin are $8.40, $9.00 ($10.50 – $1.50), and $7.20 ($9.00 – $1.80) respectively. The middle value is the replacement cost, $8.40, which becomes the designated market value for Item A. Compare it with the actual cost, $7.50, choosing the lower to value Item A in inventory. In this case, $7.50 is the value chosen to value inventory. Thus, inventory for Item A amounts to $8,250. (See Schedule B, Item A.)

9-56




PROBLEM 9-10 (Continued) Proceed in the same way, always choosing the middle value among replacement cost, net realizable value, and net realizable value less a normal profit, and compare that middle value to the actual cost. The lower of these will always be the amount at which you value the particular item. After you have aggregated the total lower-of-cost-or-market for all items, you will be likely to have a loss on inventory which must be accounted for. In our example, the loss is $950. You can journalize this loss in one of two ways: Cost of Goods Sold ................................................................. Inventory .........................................................................

950 950

or Loss Due to Market Decline of Inventory.............................. Allowance to Reduce Inventory to Market ..................

950 950

This memo should answer your questions about which value to choose when valuing inventory at lower-of-cost-or-market. Schedule A

Item

On Hand Quantity

Replacement Cost/Unit

NRV Ceiling

NRV— Normal Profit (Floor)

A B C D E

1,100 800 1,000 1,000 1,400

$8.40 7.90 5.40 4.20 6.30

$9.00 8.50 6.05 5.50 6.00

$7.20 7.30 5.45 4.00 5.00

Designated Market

Cost


$8.40 7.90 5.45 4.20 6.00

$7.50 8.20 5.60 3.80 6.40

$7.50 7.90 5.45 3.80 6.00

Schedule B Item A B C D E

Cost 1,100 X $7.50 = $8,250 800 X $8.20 = $6,560 1,000 X $5.60 = $5,600 1,000 X $3.80 = $3,800 1,400 X $6.40 = $8,960


Lower-of-Cost-or-Market 1,100 X $7.50 = $8,250 800 X $7.90 = $6,320 1,000 X $5.45 = $5,450 1,000 X $3.80 = $3,800 1,400 X $6.00 = $8,400


Difference None $240 $150 None $560 $950


9-57

*PROBLEM 9-11

(a)

Cost Inventory, January 1 .......................... Purchases ........................................... Purchase returns ............................... Totals ......................................... Add: Net markups Markups .................................... Markup cancellations .............. Totals ......................................... Deduct: Net markdowns Markdowns ................................ Markdown cancellations .......... Sales price of goods available ......... Sales .................................................... Sales returns and allowances .......... Ending inventory at retail.................. Cost-to-retail ratio =

$132,000 $200,000

Retail

$ 30,000 104,800 (2,800) 132,000

$ 43,000 155,000 (4,000) 194,000 $

9,200 (3,200)

$132,000 $ 10,500 (6,500) $154,000 (8,000)

Ending inventory at retail at January 1 price level ($59,400 ÷ 1.08)........................................................................ Less beginning inventory at retail ........................................... Inventory increment at retail, January 1 price level............... Inventory increment at retail, June 30 price level ($12,000 X 1.08) .......................................................................


(146,000) $ 50,000

$ 33,000

Beginning inventory at cost ..................................................... Inventory increment at cost at June 30 price level ($12,960 X 70%) ....................................................................... Ending inventory at dollar-value LIFO cost ............................

9-58

4,000 196,000

= 66%

Inventory at lower-of-cost-ormarket (66% X $50,000) .................. (b)

6,000 200,000


$ 55,000 43,000 $ 12,000 $ 12,960 $ 30,000 9,072 $ 39,072


*PROBLEM 9-12

(a)

The retail method is appropriate in businesses that sell many different items at relatively low unit costs and that have a large volume of transactions such as Sears or Wal-Mart. The advantages of the retail method in these circumstances include the following: 1. Interim physical inventories can be estimated. 2. The retail method acts as a control as deviations from the physical count will have to be explained.

(b)

Becker Department Stores’ ending inventory value, at cost, is $83,000, calculated as follows:

Beginning inventory ...................................... Purchases ....................................................... Net markups .......................................... Net markdowns ..................................... Net purchases .......................................

Cost $ 68,000 $255,000

$255,000

Goods available.............................................. Sales ................................................................ Estimated ending inventory at retail............

Retail $100,000 $400,000 50,000 (110,000) 340,000 440,000 (320,000) $120,000

Cost-to-retail percentage: $255,000 ÷ $340,000 = 75%. Beginning inventory layer............................. Incremental increase At retail ($120,000 – $100,000)............. At cost ($20,000 X 75%) ....................... Estimated ending inventory at LIFO cost....


$ 68,000

$100,000 20,000

15,000 $ 83,000


$120,000


9-59

*PROBLEM 9-12 (Continued) (c)

The estimated shortage amount, at retail, for Becker Department Stores is $5,000 calculated as follows: Estimated ending inventory at retail ................................ Actual ending inventory at retail....................................... Estimated inventory shortage ...........................................

(d)

9-60

$120,000 (115,000) $ 5,000

When using the retail inventory method, the four expenses and allowances noted are treated in the following manner: 1. Freight costs are added to the cost of purchases. 2. Purchase returns and allowances are considered as reductions to both the cost price and the retail price. 3. Sales returns and allowances are subtracted as an adjustment to sales. 4. Employee discounts are deducted from the retail column in a manner similar to sales. They are not considered in the cost-toretail percentage because they do not reflect an overall change in the selling price.




*PROBLEM 9-13

(a)

Cost Inventory (beginning) ....................... Purchases .......................................... Markups.............................................. Totals......................................... Markdowns......................................... Sales ................................................... Ending inventory at retail ................. Cost-to-retail ratio =

$132,000 $220,000

Retail

$ 15,800 116,200

$ 24,000 184,000 12,000 220,000 (5,500) (175,000) $ 39,500

$132,000

= 60%

Ending inventory at cost (60% X $39,500) (b)

$ 23,700

Ending inventory for 2010 under the LIFO method: The cost-to-retail ratio for 2010 can be computed as follows: Net purchases at cost

$116,200

=

Net purchases plus markups less markdowns at retail

= 61%

$184,000 + $12,000 – $5,500

December 31, 2010, inventory at LIFO cost:

Beginning inventory................ Increment in 2010 .................... Ending inventory .....................

Retail

Ratio

LIFO Cost

$24,000 15,500* $39,500

59% 61%

$14,160 9,455 $23,615

*$39,500 – $24,000 = $15,500




9-61

*PROBLEM 9-14

(a)

DAVENPORT DEPARTMENT STORE COMPUTATION OF COST OF DECEMBER 31, 2009, INVENTORY BASED ON THE CONVENTIONAL RETAIL METHOD At Cost

Beginning inventory, January 1, 2009 ................ $ 29,800 Add (deduct) transactions affecting cost ratio: Gross purchases ......................................... 311,000 Purchase returns ......................................... (5,200) (6,000) Purchase discounts .................................... Freight-in ...................................................... 17,600 Net markups ................................................. Totals ...................................................... $347,200 Add (deduct) other retail transactions not considered in computation of cost ratio: Gross sales ................................................. Sales returns ............................................... Net markdowns ........................................... Employee discounts................................... Totals ..................................................... Inventory, December 31, 2009: At retail ........................................................ At cost ($63,000 X 56%*) ............................

At Retail $ 56,000 554,000 (10,000)

20,000 620,000

(551,000) 9,000 (12,000) (3,000) (557,000) $ 63,000 $ 35,280

*Ratio of cost-to-retail = $347,200 ÷ $620,000 = 56%

9-62




*PROBLEM 9-14 (Continued) (b)

COMPUTATION OF COST OF DECEMBER 31, 2009 INVENTORY UNDER THE LIFO RETAIL METHOD

Totals used in computing cost ratio under conventional retail method (part a) .................. Exclude beginning inventory ............................... Net purchases ........................................................ Deduct net markdowns ......................................... Totals used on computing cost ratio under LIFO retail method.............................................. Cost ratio under LIFO retail method ($317,400 ÷ $552,000) ......................................... Inventory, December 31, 2009: At Retail (Conventional) ............................. At Cost under LIFO retail method ($60,000 X 57.5%).....................................


Cost

Retail

$347,200 29,800 317,400

$620,000 56,000 564,000 12,000

$317,400

$552,000

57.5% $60,000 $ 34,500



9-63

*PROBLEM 9-14 (Continued) (c)

COMPUTATION OF 2010 AND 2011 YEAR-END INVENTORIES UNDER THE DOLLAR-VALUE LIFO METHOD

Computation of retail values on the basis of January 1, 2010, price levels Cost

Retail

2010: Inventory at end of year (given) ................... Inventory at end of year stated in terms of January 1, 2010 prices ($75,600 ÷ 105%) ......................................... January 1, 2010 inventory base (given) cost ratio of 55.5% ($33,300 ÷ $60,000).... $33,300 Increment in inventory: In terms of January 1, 2010 prices .............. In terms of 2010 prices—$12,000 X 105% ...

$75,600

72,000 60,000 $12,000 $12,600

At LIFO cost—61% (2010 cost ratio) X $12,600......................................................... 7,686 December 1, 2010 inventory at LIFO cost ............. $40,986 2011: Inventory at end of year (given) ...................

$62,640

Inventory at end of year stated in terms of January 1, 2011 prices ($62,640 ÷ 108%) .........................................

$58,000

December 31, 2011 inventory at LIFO cost—55.5%* (January 1, 2010 cost ratio) X $58,000 ........................................... $32,190

9-64




*PROBLEM 9-14 (Continued) (Note to instructor: Because the retail inventory stated in terms of January 1, 2010 prices at December 31, 2010, $58,000, has fallen below the January 1, 2011 inventory base at retail, $60,000, under the LIFO theory the 2011 layer has been depleted and only a portion of the original inventory base remains. Hence the LIFO cost at December 31, 2011 is determined by applying the January 1, 2010 cost ratio of 55.5 percent to the retail inventory value of $58,000).

*Based on the beginning inventory for 2010 of


$33,300 Cost = 55.5%. $60,000 Retail



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TIME AND PURPOSE OF CONCEPTS FOR ANALYSIS CA 9-1 (Time 15–25 minutes) Purpose—to provide the student with an opportunity to discuss the purpose, the application, and the potential disadvantages of the lower-of-cost-or-market method. In addition, the student is asked to discuss the ceiling and floor constraints for determining “market” value. CA 9-2 (Time 20–30 minutes) Purpose—to provide the student with an opportunity to examine ethical issues related to lower-of-costor-market on an individual-product basis. A relatively straightforward case. CA 9-3 (Time 15–20 minutes) Purpose—to provide the student with a case that requires an application and an explanation of the lower-of-cost-or-market rule and a differentiation of the LIFO and the average cost methods. CA 9-4 (Time 25–30 minutes) Purpose—to provide the student with an opportunity to discuss the main features of the retail inventory system. In this case, the following must be explained: (a) accounting features of the method, (b) conditions that may distort the results under the method, (c) advantages of using the retail method versus using a cost method, and (d) the accounting theory underlying net markdowns and net markups. A relatively straightforward case. CA 9-5 (Time 15–25 minutes) Purpose—the student discusses which costs are inventoriable, the theoretical arguments for the lowerof-cost-or-market rule, and the amount that should be used to value inventories when replacement cost is below the net realizable value less a normal profit margin. The treatment of beginning inventories and net markdowns when using the conventional retail inventory method must be explained. CA 9-6 (Time 10–15 minutes) Purpose—to provide the student with a case that allows examination of ethical issues related to the recording of purchase commitments. *CA 9-7 (Time 10–15 minutes) Purpose—to provide the student with a number of items that might be encountered when a conventional retail or LIFO retail problem develops. The student must determine whether items, such as markdowns, markdown cancellations, sales discounts, etc. should be considered in computing the cost-to-retail percentage.

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SOLUTIONS TO CONCEPTS FOR ANALYSIS CA 9-1 (a) The purpose of using the lower-of-cost-or-market method is to reflect the decline of inventory value below its original cost. A departure from cost is justified on the basis that a loss of utility should be reported as a charge against the revenues in the period in which it occurs. (b) The term “market” in the phrase “the lower-of-cost-or-market” generally means the cost to replace the item by purchase or reproduction. Market is limited, however, to an amount that should not exceed the net realizable value (the “ceiling”) (that is, the estimated selling price in the ordinary course of business less reasonably predictable costs of completion and disposal) and should not be less than net realizable value reduced by an allowance for an approximately normal profit margin (the “floor”). The “ceiling” covers obsolete, damaged, or shopworn material and prevents serious overstatement of inventory. The “floor,” on the other hand, deters serious understatement of inventory. (c)

The lower-of-cost-or-market method may be applied either directly to each inventory item, to a category, or to the total inventory. The application of the rule to the inventory total, or to the total components of each category, ordinarily results in an amount that more closely approaches cost than it would if the rule were applied to each individual item. Under the first two methods, increases in market prices offset, to some extent, the decreases in market prices. The most common practice is, however, to price the inventory on an item-by-item basis. Companies favor the individual item approach because tax rules require that an individual item basis be used unless it involves practical difficulties. In addition, the individual item approach gives the most conservative valuation for balance sheet purposes.

(d) Conceptually, the lower-of-cost-or-market method has some deficiencies. First, decreases in the value of the asset and the charge to expense are recognized in the period in which loss in utility occurs—not in the period of sale. On the other hand, increases in the value of the asset are recognized only at the point of sale. This situation is inconsistent and can lead to distortions in the presentation of income data. Second, there is difficulty in defining “market” value. Basically, three different types of valuation can be used: replacement cost, net realizable value, and net realizable value less a normal markup. A reduction in the replacement cost of an item does not necessarily indicate a corresponding reduction in the utility (price) of the item. To recognize a loss in one period may misstate the period’s income and also that of future periods because when the merchandise is sold subsequently, the full price for the item is received. Net realizable value reflects the future service potential of the asset and, for that reason, it is conceptually sound. But net realizable value cannot often be measured with any certainty. Therefore, we revert to replacement cost because net realizable value less a normal markup is even more uncertain than net realizable value. From the standpoint of accounting theory there is little to justify the lower-of-cost-or-market rule. Although conservative from the balance sheet point of view, it permits the income statement to show a larger net income in future periods than would be justified if the inventory were carried forward at cost. The rule is applied only in those cases where strong evidence indicates that market declines in inventory prices have occurred that will result in losses when such inventories are disposed of.




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CA 9-2 (a) The accountant’s ethical responsibility is to provide fair and complete financial information. In this case, the direct method distorts the cost of goods sold and hides the decline in market value. (b) If Wright’s direct method is used, management may have difficulty in calculations that involve the cost of goods sold. For example, these calculations are useful in establishing profit margins and determining selling prices; but from the investors’ and stockholders’ viewpoint, it is not good policy to hide declines in market value. (c)

Conan should use the allowance method to disclose the decline in market value and avoid distorting cost of goods sold. However, she faces an ethical dilemma if Wright will not accept the method Conan wants to use. She should consider various alternatives including the extremes of simply accepting her boss’s decision to quitting if Wright will not change his mind. Conan should assess the consequences of each possible alternative and weigh them carefully before she decides what to do.

CA 9-3 (a) 1. Ogala’s inventory should be reported at net realizable value. According to the lower-of-cost-ormarket rule, market is defined as replacement cost. However, market cannot exceed net realizable value. In this instance, net realizable value is below original cost. 2. The lower-of-cost-or-market rule is used to report the inventory in the balance sheet at its future utility value. It also recognizes a decline in the utility of inventory in the income statement in the period in which the decline occurs. (b) Generally, ending inventory would have been higher and cost of goods sold would have been lower had Ogala used the LIFO inventory method in a period of declining prices. Inventory quantities increased and LIFO associates the oldest purchase prices with inventory. However, in this instance, there would have been no effect on ending inventory or cost of goods sold had Ogala used the LIFO inventory method because Ogala’s inventory would have been reported at net realizable value according to the lower-of-cost-or-market rule. Net realizable value of the inventory is less than either its average cost or LIFO cost.

CA 9-4 (a) The retail inventory method can be employed to estimate retail, wholesale, and manufacturing finished goods inventories. The valuation of inventory under this method is arrived at by reducing the ending inventory at retail to an estimate of the lower-of-cost-or-market. The retail value of ending inventory can be computed by (1) taking a physical inventory, or by (2) subtracting net sales and net markdowns from the total retail value of merchandise available for sale (i.e., the sum of beginning inventory at retail, net purchases at retail, and net markups). The reduction of ending inventory at retail to an estimate of the lower-of-cost-or-market is accomplished by applying to it an estimated cost ratio arrived at by dividing the retail value of merchandise available for sale as computed in (2) above into the cost of merchandise available for sale (i.e., the sum of beginning inventory, net purchases, and other inventoriable costs).

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CA 9-4 (Continued) (b) Since the retail method is based on an estimated cost ratio involving total merchandise available during the period, its validity depends on the underlying assumption that the merchandise in ending inventory is a representative mixture of all merchandise handled. If this condition does not exist, the cost ratio may not be appropriate for the merchandise in ending inventory and can result in significant error. Where there are a number of inventory subdivisions for which differing rates of markup are maintained, there is no assurance that the ending inventory mix will be representative of the total merchandise handled during the period. In such cases accurate results can be obtained by subclassifications by rate of markup. Seasonal variations in the rate of markup will nullify the ending inventory “representative mix” assumption. Since the estimated cost ratio is based on total merchandise handled during the period, the same rate of markup should prevail throughout the period. Because of seasonal variations it may be necessary to use data for the last six months, quarter, or month to compute a cost ratio that is appropriate for ending inventory. Material quantities of special sale merchandise handled during the period may also bias the result of this method because merchandise data included in arriving at the estimated cost ratio may not be proportionately represented in ending inventory. This condition may be avoided by accumulating special sale merchandise data in separate accounts. Distortion of the ending inventory approximation under this method is often caused by an inadequate system of inventory control. Adequate accounting controls are necessary for the accurate accumulation of the data needed to arrive at a valid cost ratio. Physical controls are equally important because, for interim purposes, this method is usually applied without taking a physical inventory. (c) The advantages of using the retail method as compared to cost methods include the following: 1. Approximate inventory values can be determined without maintaining perpetual inventory records. 2. The preparation of interim financial statements is facilitated. 3. Losses due to fire or other casualty are readily determined. 4. Clerical work in pricing the physical inventory is reduced. 5. The cost of merchandise can be kept confidential in intracompany transfers. (d) The treatments to be accorded net markups and net markdowns must be considered in light of their effects on the estimated cost ratio. If both net markups and net markdowns are used in arriving at the cost ratio, ending inventory will be converted to an estimated average cost figure. Excluding net markdowns will result in the inventory being stated at an estimate of the lower-ofcost-or-market. The lower cost ratio arrived at by excluding net markdowns permits the pricing of inventory at an amount that reflects its current utility. The assumption is that net markdowns represent a loss of utility that should be recognized in the period of markdown. Ending inventory is therefore valued on the basis of its revenue-producing potential and may be expected to produce a normal gross profit if sold at prevailing retail prices in the next period.




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CA 9-5 (a) 1. Olson’s inventoriable cost should include all costs incurred to get the lighting fixtures ready for sale to the customer. It includes not only the purchase price of the fixtures but also the other associated costs incurred on the fixtures up to the time they are ready for sale to the customer, for example, freight-in. 2. No, administrative costs are assumed to expire with the passage of time and not to attach to the product. Furthermore, administrative costs do not relate directly to inventories, but are incurred for the benefit of all functions of the business. (b) 1. The lower-of-cost-or-market rule is used for valuing inventories because of the concept of balance sheet conservatism and because the decline in the utility of the inventories below their cost should be recognized as a loss in the current period. 2. The net realizable value less a normal profit margin should be used to value the inventories because market should not be less than net realizable value less a normal profit margin. To carry the inventories at net realizable value less a normal profit margin provides a means of measuring residual usefulness of an inventory expenditure. (c) Olson’s beginning inventories at cost and at retail would be included in the calculation of the cost ratio. Net markdowns would be excluded from the calculation of the cost ratio. This procedure reduces the cost ratio because there is a larger denominator for the cost ratio calculation. Thus, the concept of balance sheet conservatism is being followed and a lower-of-cost-or-market valuation is approximated.

CA 9-6 (a) Accounting standards require that when a contracted price is in excess of market, as it is in this case (market is $5,000,000 and the contract price is $6,000,000), and it is expected that losses will occur when the purchase is effected, losses should be recognized in the period during which such declines in market prices take place. It would be unethical to ignore recognition of the loss now if a loss is expected to occur when the purchase is effected. (b) If the loss is material, new and continuing shareholders are harmed by nonrecognition of the loss. Herman’s position as an accounting professional also is affected if he accepts a financial report he knows violates GAAP. (c) If the preponderance of the evidence points to a loss when the purchase is effected, the controller should recognize the amount of the loss in the period in which the price decline occurs. In this case the loss is measured at $1,000,000 and recorded as follows: Unrealized Holding Gain or Loss—Income (Purchase Commitments)............................................................... Estimated Liability on Purchase Commitments........................

1,000,000 1,000,000

Herman should insist on statement preparation in accordance with GAAP. If Hands will not accept Herman’s position, Herman will have to consider alternative courses of action such as contacting higher-ups at Prophet and assess the consequences of each course of action.

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*CA 9-7 (a)

Conventional retail 3. Cost of items transferred in from other departments. 4. Retail value of items transferred in from other departments. 6. Purchase discounts. 8. Cost of beginning inventory. 9. Retail value of beginning inventory. 10. Cost of purchases. 11. Retail value of purchases. 12. Markups. 13. Markup cancellations.

(b)

LIFO retail 1. Markdowns. 2. Markdown cancellations. 3. Cost of items transferred in from other departments. 4. Retail value of items transferred in from other departments. 6. Purchase discounts. 10. Cost of purchases. 11. Retail value of purchases. 12. Markups. 13. Markup cancellations.

(Note to instructor: If the goods broken or stolen are abnormal shrinkage, they are deducted from both the cost and retail columns.)




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FINANCIAL REPORTING PROBLEM (a)

Inventories are valued at the lower-of-cost-or-market value. Productrelated inventories are primarily maintained on the first-in, first-out method. Minor amounts of product inventories, including certain cosmetics and commodities are maintained on the last-in, first-out method. The cost of spare part inventories is maintained using the average cost method.

(b) Inventories are reported on the balance sheet simply as “inventories” with sub-totals reported for (1) Materials and supplies, (2) Work in process, and (3) Finished goods. (c) In its note describing Cost of Products Sold, P&G indicates that cost of products sold primarily comprises direct materials and supplies consumed in the manufacture of product, as well as manufacturing labor and direct overhead expense necessary to acquire and convert the purchased materials and supplies into finished product. Cost of products sold also includes the cost to distribute products to customers, inbound freight costs, internal transfer costs, warehousing costs and other shipping and handling activity. Cost of Goods Sold $36,686 = Average Inventory $6,819 + $6,291 2 = 5.60 or approximately 65 days to turn its inventory, which is a decline relative to 2006 (5.86 or 62 days).

(d) Inventory turnover =

Its gross profit percentages for 2007 and 2006 are as follows: 2007 Net sales .............................. $76,476 Cost of goods sold ............. 36,686 Gross profit ......................... $39,790

2006 $68,222 33,125 $35,097

Gross profit percentage ..... 52.03%

51.45%

P&G had a small improvement in its gross profit and gross profit percentage. Sales in 2007 showed a 12.1% increase, probably due to an improving economy. It appears that P&G has been able to manage its costs to produce better gross margins on these increased sales. 9-72




COMPARATIVE ANALYSIS CASE (a) Coca-Cola reported inventories of $2,220 million, which represents 5.1% of total assets. PepsiCo reported inventories of $2,290 million, which represents 6.6% of its total assets. (b) Coca-Cola determines the cost of its inventories on the basis of average cost or first-in, first-out (FIFO) methods; its inventories are valued at the lower-of-cost-or-market. PepsiCo reported that the cost of 14% of its 2007 inventories was computed using the LIFO method. PepsiCo’s inventories are valued at the lower of cost (computed on the average, FIFO or LIFO method) or market. (c) Coca-Cola classifies and describes its inventories as primarily raw materials and packaging and finished goods. PepsiCo classifies and describes its inventories as (1) raw materials, (2) work-in-process and (3) finished goods. (d) Inventory turnover ratios and days to sell inventory for 2007: Coca-Cola $10,406 = 5.4 times $2,220 + $1,641 2 365 ÷ 5.4 = 68 days

PepsiCo $18,038 = 8.6 times $2,290 + $1,926 2 365 ÷ 8.6 = 42 days

A substantial difference between Coca-Cola and PepsiCo exists regarding the inventory turnover and related days to sell inventory. The primary reason is that PepsiCo’s cost of goods sold and related inventories involves food operations as well as beverage cost. This situation is not true for Coca-Cola. Food will have a much higher turnover ratio because food must be turned over quickly or else spoilage will become a major problem.




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FINANCIAL STATEMENT ANALYSIS CASE 1 (a) Although no absolute rules can be stated, preferability for LIFO can ordinarily be established if (1) selling prices and revenues have been increasing, whereas costs have lagged, to such a degree that an unrealistic earnings picture is presented, and (2) LIFO has been traditional, such as department stores and industries where a fairly constant “base stock” is present such as refining, chemicals, and glass. Conversely, LIFO would probably not be appropriate: (1) where prices tend to lag behind costs; (2) in situations where specific identification is traditional, such as in the sale of automobiles, farm equipment, art, and antique jewelry; and (3) where unit costs tend to decrease as production increases, thereby nullifying the tax benefit that LIFO might provide. Note that where inventory turnover is high, the difference between inventory methods is usually negligible. In this case, it is impossible to determine what conditions exist, but it seems probable that the characteristics of certain parts of the inventory make LIFO desirable, whereas other parts of the inventory provide higher benefits if FIFO is used. (b) It may provide this information (although it is not required to do so) because it believes that this information tells the reader that both its income and inventory would be higher if FIFO had been used. (c) The LIFO liquidation reduces operating costs because low price goods are matched against current revenue. As a result, operating costs are lower than normal because higher operating costs would have normally been deducted from revenues. (d) It would probably have reported more income if it had been on a FIFO basis. For example, its inventory as of December 31, 2010 was stated at $1,635,040. Its inventory under FIFO would have been $564,960 higher (2010) if FIFO had been used. On the other hand, the LIFO liquidation would not have occurred in 2010 or previous years because FIFO would have been used. Thus, the 2010 reduction in operating costs of $24,000 due to the LIFO liquidation would not have occurred.

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FINANCIAL STATEMENT ANALYSIS CASE 2

(a)

There are probably no finished goods because gold is a highly liquid commodity, and so it can be sold as soon as processing is complete. Ore in stockpiles is a noncurrent asset probably because processing takes more than one year.

(b)

Sales are recorded as follows: Accounts Receivable or Cash ........................... Sales Revenue..............................................

XXX XXX

AND Cost of Goods Sold ........................................... Gold in Process Inventory ......................... (c)

Balance Sheet Inventory Retained earnings Accounts payable Working capital Current ratio


Overstated Overstated No effect Overstated Overstated

XXX XXX

Income Statement Cost of goods sold Understated Net income Overstated



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FINANCIAL ACCOUNTING RESEARCH CODIFICATION (a) The codification provides guidance at: FASB ASC 330-10-05 (Codification String: Assets > 330 Inventory > 10 Overall > 05 Background). The primary predecessor literature is: “Restatement and Revision of Accounting Research Bulletins.” Accounting Research Bulletin No. 43 (New York: AICPA, 1953), Ch. 4. (b) According to the FASB ASC 330-10-20, the Glossary indicates the following. Inventory is the aggregate of those items of tangible personal property that have any of the following characteristics: a. Held for sale in the ordinary course of business b. In process of production for such sale c. To be currently consumed in the production of goods or services to be available for sale. The term inventory embraces goods awaiting sale (the merchandise of a trading concern and the finished goods of a manufacturer), goods in the course of production (work in process), and goods to be consumed directly or indirectly in production (raw materials and supplies). This definition of inventories excludes long-term assets subject to depreciation accounting, or goods which, when put into use, will be so classified. The fact that a depreciable asset is retired from regular use and held for sale does not indicate that the item should be classified as part of the inventory. Raw materials and supplies purchased for production may be used or consumed for the construction of long-term assets or other purposes not related to production, but the fact that inventory items representing a small portion of the total may not be absorbed ultimately in the production process does not require separate classification. By trade practice, operating materials and supplies of certain types of entities such as oil producers are usually treated as inventory. (c) According to the FASB ASC 330-10-20, the Glossary indicates the following for the term Market: As used in the phrase lower-of-cost-or-market, the term market means current replacement cost (by purchase or by reproduction, as the case may be) provided that it meet both of the following conditions: a. Market shall not exceed the net realizable value b. Market shall not be less than net realizable value reduced by an allowance for an approximately normal profit margin. (d) According to FASB ASC 330-10-35: 35-15

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Only in exceptional cases may inventories properly be stated above cost. For example, precious metals having a fixed monetary value with no substantial cost of marketing may be stated at such monetary value; any other exceptions must be justifiable by inability to determine appropriate approximate costs, immediate marketability at quoted market price, and the characteristic of unit interchangeability.




FINANCIAL ACCOUNTING RESEARCH CODIFICATION (Continued) For: Goods Stated Above Cost 50-3

Where goods are stated above cost this fact shall be fully disclosed.

35-16

It is generally recognized that income accrues only at the time of sale, and that gains may not be anticipated by reflecting assets at their current sales prices. However, exceptions for reflecting assets at selling prices are permissible for both of the following: a. Inventories of gold and silver, when there is an effective government- controlled market at a fixed monetary value b. Inventories representing agricultural, mineral, and other products, with any of the following criteria: (1) Units of which are interchangeable (2) Units of which have an immediate marketability at quoted prices (3) Units for which appropriate costs may be difficult to obtain. Where such inventories are stated at sales prices, they shall be reduced by expenditures to be incurred in disposal.




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PROFESSIONAL SIMULATION Resources

Journal Entry Cost of Goods Sold Inventory

4,000 4,000

Note: This entry assumes use of the direct method.

Explanation Expected selling prices are important in the application of the lower-ofcost-or-market rule because they are used in measuring losses of utility in inventory that otherwise would not be recognized until the period during which the inventory is sold. Declines in replacement cost generally are assumed to foreshadow declines in selling prices expected in the next period and hence in the revenue expected upon the sale of the inventory during the next period. However, the use of current replacement cost as “market” is limited to those situations in which it falls between (1) net realizable value (the “ceiling”) and (2) net realizable value less a “normal” profit (the “floor”), both of which depend upon the selling prices expected in the next period for their computation.

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